Warrants and Convertibles

Anonymous
timer Asked: Apr 23rd, 2017

Question description

1. Omniscient Inc., a producer of Telescopes a

nd Binoculars, has a total of 400,000 shares of

stock outstanding. The current market value

of Omniscient is $12 million and it has zero

debt in its capital structure. It issues a to

tal of 40,000 warrants (exercise price of $40) to its

CEO as incentive compensation.

a)

What is the price per share of Omniscient’s stock before the warrants were issued?

b)

By how much should the market value of Omni

scient increase before the CEO can exercise

the warrants?

c)

Suppose that the market value of Omniscient increases to $20 million, and

then

all the

warrants are exercised. (Note: The $20 million ma

rket value is before the exercise of the

warrants.)

(i)

What is the new price per share of Omniscient Stock?

(ii) What is the total gain for the CEO?

(iii) Instead of warrants, now assume that

the CEO holds 40,000 call options (that someone

gave as a gift) with all the other characteris

tics held the same. What would be the share

price after the exercise of the options? What is the total gain for the CEO?


2.

Ryan Home Products, Inc., issued $430,000 of

8-percent convertible bonds. Each bond is

convertible into 28 shares of common stock any time before maturity.

a)

Suppose the current price of the bonds is $1000 and the current price of Ryan common

stock is $31.25.

(i)

What is the conversion ratio and the conversion price?

(ii) What is the conversion premium?

b)

What is the current conversion value of the bonds?

c)

What will be the conversion value if the value of Ryan common stock increases by $2?


3.

Quantum, Inc. needs to raise $25 million to

construct production facilities for a new model

diskette drive. The firm’s straight non-c

onvertible bonds currently yield 14%. Its stock

sells for $30 per share; the last

dividend was $2; and the expected growth rate is a constant

9%. The firm has decided to raise the $25

million through issuing convertible bonds. The

convertibles would have a $1000 par value,

carry a coupon of 12%, have a 20-year

maturity, and be convertible into 20 shares of stock. The management intends to force

conversion when the conversion value exceeds

20% above the bonds’ par value. Quantum

has a marginal tax rate of 40%.

a)

What is the convertible bond’s straight debt value? What is the implied value of the

convertibility feature if the convertible bonds were sold at par?

Homework #4

Sudha Krishnaswami Lecture Notes

Page 3 of 3

b)

Compute the year in which the bonds are expected to be converted (forced conversion).

c)

What is the expected before-tax yield on th

e convertible bonds to the investors if the bonds

are sold at par? Compute the after-tax cost to Quantum if the bonds are sold at par.


4.

Florida Enterprises is considering issuing a

10-year convertible bond that will be priced at

its $1000 par value. The bonds have an

8% annual coupon, and each bond can be

converted into 20 shares of common stock. The

stock currently sells at $40 a share, has an

expected dividend in the coming year of $5, and

has an expected constant growth rate of

5%. Similar straight-debt issues yield 10%. The company will force conversion on the

bonds as soon as (year-end) the conversion va

lue exceeds the par value on the bonds. The

firm is in the 40% marginal tax rate.

a)

Compute the price of the straight bond component and the conversion value in Year 3.

b)

When will conversion take place?

c)

Compute the yield to the investors and the cost to the firm from the convertible bonds.

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